Chapter 2. Set your Budget

Welcome to the exhilarating world of budgeting—where dreams of Lamborghinis clash with the harsh reality of ramen noodle dinners. Step one: figure out how much cash you've got stuffed under your mattress (or, you know, in your bank account if you're fancy like that). And for those of us whose wallets scream more "ouch" than "cha-ching," it's time to get creative.

Sure, it's easy to get starry-eyed over that flashy monthly payment, but let's not forget about the other monsters hiding under the bed. We're talking insurance, fuel (because apparently, cars run on something other than hopes and dreams), repairs (because apparently, cars break down more often than your grandma's bingo buddies), and those sneaky registration fees that pop up like surprise birthday parties. As a golden rule of thumb (or pinky, if you prefer), aim to keep your total car-related expenses to a modest chunk of your monthly dough—think somewhere between 10% to 15% of your take-home pay.

And hey, while you're juggling those pennies, consider treating yourself to a little slice of luxury. I'm talking about all those fancy doodads and gizmos that come with the latest models—like automatic emergency braking (because who needs the adrenaline rush of a last-minute swerve?), blind spot intervention (because apparently, we've all forgotten how to shoulder check), and external 360-degree cameras (because parallel parking is basically a real-life game of Tetris). Who says you can't have your cake and drive it too?

First and foremost, it's important to know what your new expenses would be versus current expenses. Get a Monthly Budget worksheet for online entry or printing and enter your current expenses. Then as you work through this guide and add estimated new expenses to the worksheet, it will help you settle on a budget range.

If you just want to estimate expenses, Edmunds has a useful True Cost to Own® (TCO®) metric that incorporates depreciation, interest on your loan, taxes and fees, insurance premiums, fuel costs, maintenance, and repairs: edmunds.com/tco.

As part of the budgeting process, consider buying with financing vs. leasing if you haven't already decided. Using this Bankrate buy vs. lease calculator can help determine the best option based on your financial status and how you plan to use your vehicle. Of course, if you're among the approximately 20% of buyers who pay cash, skip to the Insurance, Repairs, and Maintenance sections below.

Buy vs. Lease

Buy

Buying a car with financing from a lending institution offers the benefits of building equity and eventually owning the vehicle, with no mileage limits or extra charges for unusual wear and tear and damage. A portion of your payment goes toward paying down the principal and a smaller portion for the interest. The higher the interest rate and lower the down payment the higher the monthly payment, so your goals would be to find the lowest interest rate and make as big a down payment as is practical.

Pros

You build equity in an asset and be able to sell it if needed, and eventually own it.
No need to be concerned about limiting the miles driven.

Cons

Unless the down payment is fairly large, you will be upside-down on the loan due to high depreciation immediately and during the first year—typically 20-25% of the original value.
This will make it difficult to sell or trade-in the vehicle during the first few years of the loan term, and the longer the loan term the worse the upside-down amount will be. Bankrate has good advice on how to deal with and avoid an upside-down situation.

Lease

For those who are not familiar with leasing, it's simply a way to only pay for interest and the portion of a car's value that you use, or its depreciation. You will still need to pay the tax and license fees, and usually make a down payment as well.

You will also need to pay for maintenance as leases do not cover it unless you buy a maintenance package. The monthly amount that you will pay is based on the miles allowed in the lease plus depreciation, and when the lease is over you just give it back—unless there is damage beyond normal wear and tear or you've gone over the mileage limit. The charge for excess miles will typically be between $0.10 and $0.25, but you will have the option to buy the vehicle for the residual value speci􀁻ed in the lease, in which case the excess mileage will not matter. The typical lease term is 12 to 36 months.

If you need to get out of your lease, you can do it in the same way you would get out of a loan: there is a payoff to the bank that you need to pay. You can either sell the car privately, or sell it to a dealer. If you sell the car for the same amount as you owe, you pay the bank and are out of the lease. If you sell it for less, you must come up with the difference, and if you sell it for more you make profit.

As noted earlier, when you lease you are paying for interest and depreciation. Interest is determined by the leasing company based on current market rates, the lease term, the vehicle's age, and your credit score, and for leases it's called the "money factor". The rates can vary widely, and manufacturers frequently offer special low lease rates as part of their sales and marketing promotions for new cars.

Depreciation is projected by the leasing company, and is a combination of the car's age, mileage, condition and brand/model. It results in an assumed value of the car at lease-end and this is typically built into the most common type of leases, called the "closed-end" lease. If you want to minimize payments and have no intention of keeping the car at lease-end, you want this number to be higher so you will pay less depreciation, but you have no control over it except for vehicle selection.

While the residual value of the car must be disclosed, and cannot be changed by the dealer, the money factor can be raised by some banks while some don’t allow rate mark-up. The final element determining your payment will be the selling price of the car, which is called “capital cost” for leases. Selling price in a lease can be negotiated in the same way as purchase price, so the lower it is, the lower the amount of depreciation you will have to pay in the lease.

Pros

Lower monthly payment, with the average on a lease $586 vs. $729 for financing.
(Experian, Q2 2023). But beware of the many low cost, low mileage lease offers and don't underestimate how many miles you're likely to put on the car.
Ability to get a more expensive and better equipped vehicle than you can afford to buy, for the same or lower monthly payments than financing.
A fresh new vehicle to drive during its most trouble-free years, with full warranty and the latest technology and safety features after every lease term—which averages 36 months.
You can buy the vehicle at the end of the lease, which may be good deal depending on its then current market value.
If you are interested in an Electric Vehicle (EV) or Plug-in Electric Vehicle (PHEV), there are several advantages to leasing:
- There are more vehicle options when leasing EV/PHEV vs. buying in order to get the Federal $7,500 tax credit. But be sure to know the capital cost, or selling price as some dealers will mark it up from MSRP/Sticker Price for vehicles that are eligible for the credit.
- New vehicles are coming into the market on a regular basis, often with very aggressive lease terms.
- The EV/PHEV market is more volatile than Internal Combustion Engine (ICE) vehicles. So a lease protects you against wild swings in selling prices, used car values, and price reductions by your and other vehicle brands.
- EV technology is advancing so rapidly that battery range can increase and purchase prices may drop over a relatively short period of time.

Cons

Overall higher cost in most cases.
No equity being built up, so you don't own anything after the lease term is up, and you’re paying for the car during the time of it's highest depreciation.
A never ending cycle of car payments.
If it turns out that you don’t like the vehicle or can’t afford the payments, you willpay early termination fees and penalties.

Buy - Financing

Use the popular 20/4/10 guideline as a good starting point for planning, which recommends a 20% down payment, a four-year loan, and total vehicle costs under 10% of your monthly income. There will of course be circumstances when it's not possible to follow it exactly, but try to stick as close as possible to ensure you can afford the car and will be less likely to be upside down on the value vs. the remaining balance.

Next, run some numbers and scenarios through one of the many online loan calculators, with our recommendations being those at Edmunds and NerdWallet.

Third, check your credit scores so you will have some idea of the loan amount and terms that you can get. It's hard to know which of the three credit bureaus your lenders will use—Equifax, Experian, or TransUnion, but you can get all three scores from any one of them for a fee. Free credit reports are available once per year at annualcreditreport.com, which is the only source for the free reports required by the U.S. Government. But they just include detailed credit history and not a credit score which usually costs extra. An increasing number of banks and credit card issuers provide a free credit score from one of the three bureaus for their customers, so check if any of yours do. You can also find a variety of free credit score offers by doing a Web search for "free credit score", but there are usually strings attached.

Fourth, try to get pre-qualified for a certain loan amount and terms, which will give you a negotating advantage when comparing dealership financing options when ready to buy. Explore the following six options:

1. Your Current Bank or Credit Union

Check with your current bank or credit union and see what loan types and rates they offer. Since you already have a relationship and credit history, you may be able to get better terms and more personalized service. Credit unions tend to to offer more affordable terms than other financial institutions since they are member-owned cooperatives, so even if your bank offers what appears to be a good loan, it's best to compare it with a credit union. If you're not already a member, it's easy to find one that your can join in your area at the official U.S. Government National Credit Union Administration site.

2. Loan Comparison Websites

For access to optimal loan terms, comparison websites offer a quick and easy solution. A single application unleashes offers from diverse lenders, be they local credit unions, established banks, or even nationwide financiers. Nearly all of the recommended information and shopping sites listed in Chapter 8 -Website Directory will have links to apply for financing from multiple lenders. For an independent search, here are some of the best places to explore:

Bankrate www.bankrate.com/auto
Credit Karma www.creditkarma.com/shop/autos/index/type/newpurchase
NerdWallet www.nerdwallet.com/h/category/auto-loans
MarketWatch www.marketwatch.com/guides/car-loans/best-auto-loan-rates

3. National and Regional Banks

All banks naturally provide vehicle loans, but under widely varying terms and conditions. The largest national banks boast extensive locations, offer a wide range of products and services, and provide many online and mobile banking features. However, their fee and loan rates are usually higher and they often have more stringent policies, potentially presenting hurdles for borrowers facing credit blemishes or unconventional financial circumstances.

Regional and local banks may not offer as wide a range of products and services as national banks, may have fewer ATMs and branches, their hours may be more limited, and they may not have as advanced online and mobile banking features. However, they often charge lower fees and interest rates than national banks and can offer more personalized service.

4. Online Banks

Online banks, also known as internet, virtual, or web banks, are also a great source for vehicle loans. They are financial institutions that operate primarily or entirely online, without the need for physical branches. You manage your finances entirely through their websites and mobile apps. Some benefits of using an online bank may be lower interest rates with easier and faster loan processing times. Three of the highest rated online banks are:

Ally Bank: Praised for consistently high APYs on savings accounts, user-friendly interface, and excellent customer service
Discover: Renowned for fee-free banking, high-yield savings accounts, and cashback debit rewards
Capital One 360: Offers a hybrid model of online and physical banking, boasting comprehensive products and no-fee options

5. Finance Companies

A finance company is an organization that provides loans to individuals for cars, furniture, appliances, and other consumer goods. Unlike a bank, they typically don't take deposits or offer checking accounts. There is wide range of such companies, and the best way to find those actively in vehicle loans is in the finance sections of the car sales websites listed in Chapter 8 - Website Directory.

There are also "captive" finance companies, which are owned by vehicle manufacturers and work through their brand's franchised dealership network. These will be presented as financing options at their respective dealerships, sometimes along with third party lenders. However, before going shopping, first explore the options listed above to get pre-qualified, then when ready to buy, see if the dealers can meet or beat the terms.

The pre-approved amount may not be guaranteed for any specific car, as factors like the final sales price and insurance cost might influence the final loan approval, but it still helps. In some instances the dealer can beat other offers simply because the manufacturer may have discount incentives built-in to move certain vehicles or at certain times of the year. The main examples are:

American:

Ford Motor Company: Ford Credit
General Motors: GM Financial
Chrysler: Chrysler Capital (partnered with Ally Financial)

Asian:

Toyota Motor Corporation: Toyota Financial Services
Honda Motor Company: Honda Financial Services
Nissan Motor Company: Nissan Finance
Hyundai Motor Group: Hyundai Motor Finance

European:

Volkswagen Group: Volkswagen Financial Services
Stellantis: Stellantis Financial Services (acquired from Chrysler)
BMW Group: BMW Financial Services
Daimler AG: Mercedes-Benz Financial Services

6. Independent Car Dealerships

Most independent car dealerships offer to provide financing, but they are actually just acting as a broker between the customer and local banks, finance companies, or credit unions. The dealership will make money either from a fixed fee paid by the lender, or by adding a small percentage on top of the lender's interest rate.

You should try to get a pre-qualification using one of the options above, to have in hand before buying so you can compare the terms. The pre-qualified amount may not be guaranteed for any specific car, as factors like the final sales price and insurance cost might influence the final loan approval, but it still helps.

There are some independent dealerships that handle their own financing, referred to as Buy Here Pay Here (BHPH), and they tend to specialize in vehicles for people with poor or no credit. Their lending practices can be predatory, their vehicles tend to be overpriced, and they don't always report to credit bureaus which will not help your credit score. So be sure to explore all other options before taking this route. A popular one is DriveTime, also listed in Chapter 8 - Website Directory .

Lease - Financing

If you choose to lease, it's best to first search all of the franchised dealerships in your area for available deals on the vehicles you're interested in. While some banks and credit unions do offer leases, they are not as common as loans, so it's usually best to lease from the dealer directly, especially since any available promotions and incentives will usually be built-in.

While the monthly payment is often the focus of the deal, it's still important to set your budget and to stay within it. Also, as with buying, the advertised price is usually just a starting point. You can negotiate the capitalized cost (purchase price of the car), money factor (interest rate), down payment, and mileage allowance. It's also important to read the fine print which will have additional terms compared with a purchase as there may be hidden fees, excess mileage penalties, excess wear and tear, and early termination clauses. Also keep in mind that leasing a car generally requires better credit than financing. Here is some general advice:

Consider shorter lease terms: This minimizes depreciation and reduces the risk of exceeding mileage limits.
Don't put too much money down: While a larger down payment will lower your monthly payment, it's money you won't get back at the end of the lease.
Since lease deals change frequently, do a Web search for the latest nationwide lease and purchase deals using the search phrase: "best car lease deals". For a local search, use "best car lease deals near <your city and state>".

Insurance

Property & Liability Insurance

Before you purchase or lease a vehicle, it’s important to factor in the cost of insurance, which is not just a safeguard for the investment you made when you purchased or leased your vehicle.

In the event of a severe accident, the expenses for property damage and injuries can quickly add up to hundreds of thousands of dollars. If you are responsible for such an accident, the affected parties may take legal action against you. In such a scenario, your assets, including your savings and home, could be at risk of being seized.

Liability auto insurance provides a safety net between the amount you owe and your assets in the event of an accident. That’s why selecting the appropriate liability limits is the most crucial aspect of comparing car insurance quotes. Liability coverage is typically represented by three numbers, such as 50/100/50 or 250/500/250. These numbers correspond to individual injuries, total injuries, and property damage, respectively. Insurers refer to these as bodily injury liability, total bodily injury liability, and physical damage liability.

For example, if you choose a policy with 100/300/100 limits, you’ll be selecting:

$100,000 for bodily injuries per person in an accident that you caused.
$300,000 total for all bodily injuries in an accident that you caused.
$100,000 for damage to any property in an accident that you caused, including cars, buildings, and objects like fences and mailboxes.

GAP Insurance (Guaranteed Asset Protection)

An optional car insurance coverage that helps you financially if your car is totaled or stolen. It covers the difference between the car's depreciated value and what you still owe on your loan or lease. GAP insurance is not required and typically adds extra cost to your insurance premium. Whether to get GAP insurance or not depends on your specific financial situation and risk tolerance.

Gather your Information

To quickly and easily compare car insurance alternatives, you should have the following on hand:

Personal information, including the name, address, birth date, occupation, driver’s license and marital status of everyone who will be on the policy
Make, model, year, and VIN, if you have already purchased the car or have this data in advance. At a minimum, at least have the make, model and year but the quote will be more accurate with a VIN.
Driving history, including all claims and moving violations over the past five years for everyone who will be on the policy.
Current or previous insurer’s name for anyone on the policy, or living in your household. Most insurers won’t provide coverage without current or recent coverage history, and if you want to exclude anyone living with you from the policy, you’ll proof that they are covered under another policy.
Current or previous insurer’s name for anyone on the policy, or living in your household. Most insurers won’t provide coverage without current or recent coverage history, and if you want to exclude anyone living with you from the policy, you’ll proof that they are covered under another policy.
The types and levels of coverage that you need. It’s very important to look at this closely to get the right coverage at the right price as it’s very easy to under-insure or over-insure. Here are a few good resources that will help you decide:

Gather Quotes

You can get quotes for the car(s) that you are considering in several ways, but the best and most efficient options are 1 or 2 below. With options 3 or 4, you will need to input your information multiple times, or keep getting shuffled among various insurance company and agent websites.

Contact your current agent or company directly and get quotes. If you are considering a Tesla, they offer their own insurance: www.tesla.com/insurance.
Find a reputable independent insurance agent who will gather your information and help you find the best policy among several insurers.
Contact the major insurers and get quotes online from AAA, Allstate, Farmers, Geico, Mercury, Nationwide, Progressive, Safeco, State Farm, etc.
Get multiple quotes online at once at aggregator websites such as:
1. Bankrate www.bankrate.com
2. Insure www.insure.com
3. NerdWallet www.nerdwallet.com/a/insurance/car-insurance
4. Policy Genius www.policygenius.com/auto-insurance/reviews
5. Quotes Match www.quotesmatch.com
6. Quote Wizard www.quotewizard.com
7. The Zebra www.thezebra.com/car-insurance-quotes
8. US News www.usnews.com/insurance/auto

With quotes in hand, add the cost for the policy of choice to your Monthly Budget worksheet. Here is some excellent insurance advice from Consumer Reports, but you'll need a $39/year subscription for full access:

Insurance adjuster inspecting vehicle damage

Repairs

Repairs are unpredictable, and a function of the vehicle's age, condition, and the vehicle's or brand's quality and reliability history. Choosing a vehicle and brand that has a good dependability/reliability rating is the best you can do.

Consumer Reports provides a continually updated Guide to Car Reliablity & Owner Satisfaction (subscription required).

J.D. Power performs annual dependability studies, and their approach and results are somewhat different than Consumer Reports: www.jdpower.com/cars/ratings.

Both Consumer Reports and J.D. Power dependability and reliability ratings assess car quality, but they have some key differences in methodology and coverage:

Focuses:

Consumer Reports: Primarily focuses on reliability (similar to J.D. Power) with performance and safety into an overall satisfaction score. Reliability is weighted more heavily than the other factors.
J.D. Power: Primarily focuses on dependability, looking at problems reported by owners in the first three years of ownership. These problems encompass a wide range of issues, from minor inconveniences to major breakdowns.

Methodologies:

Consumer Reports: Surveys its own members, which can create a bias towards more engaged and potentially more critical owners.
J.D. Power: Surveys a broad range of vehicle owners, not just subscribers. They use a statistically representative sample to ensure their results reflect the wider population.

Below is a summary of the key differences:

Consumer Reports

Focus: Reliability, performance, safety
Methodology: Surveys own subscribing members
Data Analysis: 5-point rating scale, detailed reports
Overall: Broad assessment of car satisfaction

J.D. Power

Focus: Dependability (problems in first 3 years)
Methodology: Surveys broad range of owners
Data Analysis: PP100 score, breakdown by problems
Overall: A comprehensive picture of dependability in first 3 years

To get repair estimates by make, model, year and repair type, here are some popular Web services:

AAA www.aaa.com/autorepair/estimate
Kelley Blue Book www.kbb.com/auto-repair
NAPA www.napaonline.com/en/auto-care/car-repair-estimator
RepairPal www.repairpal.com/estimator

Recommendation: Get quotes for extended service plans. Consider whether to buy one, or set aside the monthly cost in a savings account to pay for or offset repairs when needed. If you choose a reasonably reliable vehicle, the odds are that you will come out ahead.

Here are some popular service plans:

Autopom! www.autopom.com
CarChex www.carchex.com
CarShield www.carshield.com/protection-plans
Endurance www.endurancewarranty.com
Omega Auto Care www.omegaautocare.com

Maintenance

In contrast to repairs, maintenance is 100% predictable since the requirements and recommended schedules are published for every vehicle, either in the owner's manual, at the manufacturer's or dealer's website, or at third party service provider shops and various websites. Get the maintenance schedule for the vehicle(s) you're interested in and check the cost of the services.

If it's a new car:

Is there a maintenance plan included in the price, and if so what does it cover and for how long and how many miles?
If there is no maintenance plan included, ask for one to be added at no cost. They will probably try to sell you a contract but these are often not worth it as their list prices are high—so ask for a big discount.
If there is no maintenance plan available or one that meets your needs and budget, just get the recommended service done by a qualied independent shop.
Edmunds provides estimates by vehicle make, model, and year.

If it's a used car:

Are there maintenance records and receipts available?
Get the maintenance schedule from the vehicle manufacturer's website.
Contact a dealer that sells and services the vehicle and get their prices.
Contact a few independent maintenance/repair shops and get their prices; many will have online access to recommended maintenance schedules.
Edmunds provides estimates by vehicle make, model, and year